Using Credit Cards to Improve Your Credit
Excellent credit begins with how well a consumer handles all financial aspects of life. Responsibly managing a mortgage, credit cards, auto and personal loans and even their cell phone service will add depth to an individual’s credit history and increase their credit score. Credit scores influence whether a loan or line of credit is approved, the higher the score the better the chance of securing a mortgage, loan or credit card.
One common misunderstanding of establishing excellent credit is that zero balances on your credit accounts will earn an excellent credit score. But that’s just not the case. Lenders want to know that you can actually manage your account and, as grand a gesture is of paying off the balance every month, it doesn’t convey the ability to handle debt in the midst of financial uncertainty. So, even if you have the financial stability to pay off the balance, allow one or two accounts to carry a small balance each month.
Good credit consists of a variety of loans and credit accounts, not only by how you manage revolving debt like Visa, MasterCard, and store credit cards. It’s also affected by how you handle fixed payments, like your car payments or your mortgage payments, over time. A mix of credit cards, loans, mortgages and other lines of credit will benefit the bottom line. When it comes to credit cards, there are several points that need to be addressed to help secure a healthy score and credit history:
Inactive Credit Cards – Consumers often ask if they should close credit cards that they are no longer using. The simple answer is ‘no’. An inactive card has no negative impact by sitting in a desk drawer; plus, older accounts have more value than new ones. In contrast, if you cancel a credit card, you may see a drop in your credit score. By canceling a credit card your total credit limit will be reduced. This is important because it’s one of the factors in determining your credit score - the amount of available credit you have compared to the amount of outstanding debt. You want to keep your allowable credit as high as possible, which means inactive cards should remain open.
Opening New Accounts – Opening a new credit card account, in and of itself, does not have a negative impact on your credit score – unless you apply too often. Every time you apply for a new credit card, the application generates a hard inquiry on your credit report. Too many inquiries may indicate financial trouble and result in having your application denied. This not only applies to credit cards but all other credit or loan applications, as well. Note: These inquiries stay on your credit report for two years but only impact your credit score for the first year.
An Important Balancing Act
Maintaining a balance on your credit accounts is not all bad, but if you’re anywhere near the limit, you will see a negative effect on your score. You should never use more than 50% of your credit limit; a lower percentage is even better. For example, if your credit limit is $2,000, you shouldn’t have a balance of more than $1,000. By keeping a majority of the credit line available you will show lenders that you’re managing your finances properly.
Credit Increase: Pro or Con – Asking for an increase on your credit limit can both help and hurt your credit score. The credit review process that occurs prior to an increase in your credit line may cause a dip in your score. However, the increase in your credit limit will improve your credit score by increasing the ratio of credit used to credit available.
Keep Them Active – Financial experts suggest that consumers use every active account at least once every six months. It only takes a small purchase to keep an account open and maintain the credit limit.
The importance of maintaining credit card debt responsibly cannot be underestimated. Late or missed payments are an absolute deal breaker when looking to earn an excellent credit rating. More than any other type of loan, credit cards reap the biggest boost to your score when paid off. So if you have a choice between paying off your car loan or your credit card, opt for the plastic.
